Borrowing, Investing & Tax Deductibility Issues

If your boat qualifies as a "second home" (see section below on the tax deductibility of interest on boat loans) there may be advantages to financing your boat purchase instead of paying cash or liquidating assets to do so. By maintaining cash or assets/securities, investment earnings may exceed the cost of marine financing.

As an example, assume obtaining a marine loan for a qualified "second-home boat" of $100,000 at a fixed interest rate of 6% with a 20-year term; the monthly principal and interest payment is $716. The interest cost of this loan over an anticipated 60 months is $27,886. For a boat buyer in the 30% tax bracket, the interest expense deduction will save him or her $8,366, effectively reducing the cost of the loan to $19,520.

Now compare investing (or leaving invested) that $100,000 and assume it can earn 8% annually; it will grow to $132,853 (after tax) in that same 60-month period. In essence, staying invested provides a greater return -- more than $13,000 -- than paying cash or liquidating assets to purchase the boat.

Marine lenders can provide additional examples and details comparing paying cash vs. financing, and in many cases, financing can cost less. As always, it's prudent to consult a financial advisor about an individual's personal tax situation.

Tax Deductibility of Interest on Boat LoansInternal Revenue Code (IRC) section 163 (h) (2) states that a taxpayer may deduct any qualified interest on a qualified residence. Qualified residences are defined as a principal residence (e.g., a primary home) and one other residence (including second homes) owned by the taxpayer for the purpose of deductibility for the tax year. IRC section 163(h)(3) defines qualified residence interest as any interest paid or accrued during the tax year on acquisition or home equity indebtedness with respect to any qualified residence of the taxpayer.

According to IRC section 163(h) (4), a boat will be considered a qualified residence if it is one of the two residences chosen by the taxpayer for purposes of deductibility in the tax year. A qualified residence must have basic living accommodations including sleeping space (berth), a toilet (head), and cooking facilities (galley). If the boat is also chartered, the taxpayer will have to use the boat for personal purposes for either more than 14 days or 10% of the number of days during the year the boat was actually rented, to qualify for the interest deduction in accordance with IRC section 280A(d)(1).

Form 1098, issued by lenders, is not necessary in order to claim the qualified interest deduction. In accordance with IRS instructions for Schedule A, form 1040, if the taxpayer does not receive form 1098, deductible mortgage interest should be reported in line 11 instead of line 10 on Schedule A.

Borrowing against an unencumbered home to purchase a "second home boat" has limitations. Home mortgage interest deduction is limited to interest paid on mortgage debt used to purchase or improve a residence, or to refinance the remaining balance on a purchase or improvement. If the money isn't used for the home, the interest expense does not qualify for the deduction.

Interest paid on a home equity loan to buy a boat also may not be deductible. Home mortgage interest deduction is limited to interest paid on home equity loans up to $100,000. By using a home equity loan, you may limit the amount of interest that is deductible, if a boat loan balance exceeds $100,000.

Borrowing against a stock portfolio to purchase a boat creates complications in regard to interest deductibility. Second home mortgage interest deduction is limited to interest paid on second homes that are secured by that second home. A written collateral agreement (security agreement) from a broker indicating the boat as collateral is something brokers are not inclined to provide.